Rule changes needed to make the currency work are in an economic sense small, writes Joseph Stiglitz

That Europe, and especially the eurozone, has not been doing well since the 2008 crisis is beyond dispute. The single currency was supposed to bring prosperity and enhance European solidarity. It has done just the opposite, with depressions in some countries even greater than the Great Depression. To answer the question about what is to be done, one has to answer another: what went wrong. Some claim that policymakers made a set of mistakes — excessive austerity and poorly designed structural reforms. In other words, there is nothing wrong with the euro that could not be fixed by putting someone else in charge.

I disagree. There are more fundamental problems with the structure of the eurozone, the rules and institutions that guide and constitute it. These may well be insurmountable, raising the prospect that the time has come for a more comprehensive rethinking of the single currency, even to the point of unwinding it. Put simply, the euro was flawed at birth. It was almost inevitable that taking away two key adjustment mechanisms, the interest and exchange rates, without putting anything else in their place, would make macro adjustment difficult. Add to that a central bank mandated to focus on inflation and with countries still further constrained by limits on their fiscal deficits, the result would be excessively high unemployment and gross domestic product consistently below potential output. With countries borrowing in a currency not under their remit, and with no easy mechanism for controlling trade deficits, crises too were predictable . The alternative to adjusting nominal exchange rates is adjusting real ones — having Greek prices fall relative to German prices. But there are no rules in place that could force a rise in German prices and the social and economic costs of forcing Greek prices to fall enough are enormous. One might dream of Greek productivity growing faster than that of Germany as an alternative way of “adjusting,” but no one has figured out how to do it. So too for Spain and Portugal. In the absence of a grand strategy, the troika of international institutions has flailed around, putting in place new rules for defining fresh milk or the size of loaves of bread. Whether these are desirable can be debated; that they are not going to achieve the desired adjustment in real exchange rates cannot. The rule changes needed to make the euro work are in an economic sense small. A common banking union, most importantly common deposit insurance; rules to curtail trade surpluses; and eurobonds or some other similar mechanism for mutualisation of debt. Monetary policy to focus more on employment, growth and stability, not just inflation. Meanwhile, industrial and other policies should be orientated to helping the laggard countries catch up to the leaders. Most importantly: a move away from austerity towards growth oriented fiscal policies. But these seem well beyond the politics of Europe today, with Germany still arguing that “Europe is not a transfer union.”Good currency arrangements cannot ensure prosperity; flawed ones lead to recessions and depressions. And among the kinds of currency arrangements long associated with recessions and depressions are pegs, where the value of one country’s currency is fixed relative to another. A single currency is neither necessary nor sufficient for close economic and political co-operation. Europe needs to focus on what is important to achieve that goal. An end to the single currency would not be the end of the European project. The other institutions of the EU would remain: there would still be free trade and migration. It is important that there can be a smooth transition out of the euro, with an amicable divorce, possibly moving to a “flexible-euro” system, with say a strong Northern Euro and softer Southern Euro. Of course, none of this will be easy. The hardest problem will be dealing with the legacy of debt. The easiest way of doing that is to redenominate all euro debts as “Southern Euro” debts. As we move to a digital economy, modern technology enables a set of market-based reforms that can simultaneously achieve the triple goals of full employment, trade balance, and fiscal balance, through credit auctions and electronic trade tokens. In the current global system, we rely on central banks to set interest rates, hoping somehow that the resulting trade balance, investment, and consumption will be “right.” They typically aren’t. The alternative approach focuses on the quantities of, say, investment and trade balance, that we need, and lets the market set the price to achieve this. Over time exchange rate variations could become more limited as institutions develop. The flexible euro is a strategy for incorporating the advances in economic integration already made while providing the space for reforms. The single currency was supposed to be a means to an end. It has become an end in itself — one that undermines more fundamental aspects of the European project, as it spreads divisiveness rather than solidarity. An amicable divorce — a relatively smooth end to the euro, perhaps instituting the proposed system of the flexible euro — could restore Europe to prosperity and enable the continent to once again focus, with renewed solidarity, on the many real challenges that it faces. Europe may have to abandon the euro to save Europe and the European project.The writer, a Nobel laureate in economics, is author of “The Euro: How a Common Currency Threatens the Future of Europe”

The Fed Is Searching for a New Framework. New Minutes Show It Doesn’t Have One Yet

Neil Irwin

The quandary facing the Federal Reserve this summer is the same as it was back in the spring, and winter, and last fall: By traditional guideposts like the unemployment rate, it looks as if it is time for the Fed to be raising interest rates. Yet the global economy seems to be locked in a low-growth, low-inflation world in which raising interest rates is at best unnecessary and at worst dangerous.

That tension was on display Wednesday in the minutes of the Fed’s last policy meeting, which raised the possibility of rate increases as early as September.

As is the Fed’s standard practice, the description of the meeting was stripped of names and summarized in bloodless language. But reading between the lines, it is clear there was a rich debate over what factors the Fed should be weighing, and how, in making its next move.

Some policy makers saw evidence that the labor market was getting tighter, the result of which should be higher wages and prices. Others “saw little evidence that inflation was responding much” to the low jobless rate. With inflation low, “many judged it was appropriate to wait for additional information” before considering raising rates.

“Several” suggested there would be plenty of time to react if inflation did rise and so wanted to defer raising rates until it was clear inflation was holding near its desired target of 2 percent.

“Some other participants” viewed the economy as already being near full employment, meaning that another rate increase “was or would soon be” warranted.

The result of all that debate at the July 26-27 meeting was affirming the status quo — agreement that “it was prudent to accumulate more data in order to gauge the underlying momentum in the labor market and economic activity” and that “members judged it appropriate to continue to leave their policy options open and maintain the flexibility to adjust the stance of policy based on incoming information.”

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Janet Yellen, chairwoman of the Federal Reserve, continues to face a tricky situation in deciding what to do about interest rates.Credit Charles Krupa/Associated Press

That continues a volatile year for market perceptions of when, and how much, the Fed might make the shift toward tighter money. At the start of 2016, it seemed nearly certain the Fed would follow up its interest rate increase in December with more of them this year.

Weak growth in the United States and abroad, combined with a volatile first half of the year in financial markets, drove the odds of a rate increase down to 12 percent by July 1, based on prices in futures markets. That had gone back up to 53 percent by Tuesday. (It edged down very slightly, to 51 percent, after the release of the minutes Wednesday.)

In public comments this week, Fed officials have suggested that markets are underrating the possibility of a September rate increase.

“We’re edging closer toward the point in time where it will be appropriate, I think, to raise interest rates further,” the New York Fed president, William C. Dudley, told Fox Business on Tuesday. The Atlanta Fed president, Dennis Lockhart, told reporters that one or two rate increases are possible this year and that economic data would suggest strong consideration of raising rates next month.

The Fed faces a profound question: Is the basic framework it has used over the last generation to set monetary policy the correct one in this moment, or has something fundamental shifted in the global economy that calls for a new one?

If this is just a standard economic expansion that has been slowed by some bad luck, then the central bank’s usual rules apply. That rule book involves examining how close the economy is to functioning at its full potential, and trying to move up and down to keep on that steady path so as not to let inflation get out of control.

By that standard, it is past time to be raising interest rates. The unemployment rate is 4.9 percent, around the level the Fed believes is sustainable in the longer term, and job growth is strong. Inflation was 1.4 percent over the last year, according to the index the Fed watches most closely, not too far below the 2 percent the Fed aims for. And mainstream economic models project it should rise in the years ahead given the relatively tight job market.

But there is plenty of evidence — and a vocal contingent of officials inside the central bank — that the usual way of thinking isn’t quite working.

For one thing, the rest of the world is growing so slowly that it is creating a steady downdraft on inflation and growth that may mean the usual worries about inflation don’t apply. Rising wages for American workers over the last year or so have been counteracted by other forces preventing inflation from taking off, including falling energy prices and slack demand for goods and services from overseas.

Moreover, any step the Fed takes toward tightening the United States money supply seems to be offset by an opposite reaction elsewhere. With other countries easing monetary policy with ultralow interest rates and quantitative easing, small moves to tighten American policies have created outsize rallies in the dollar, which disadvantages American exporters and creates ripple effects through the global credit system.

That has led Fed officials to steadily mark down both their expectations for how quickly to raise short-term interest rate and where those rates will settle in the longer run — meaning they think that low rates may be more a new normal than a short-term aberration.

The San Francisco Fed president, John Williams, raised the possibility this week of more significant change in how the Fed thinks about its goals, even raising the possibility of increasing the Fed’s 2 percent target for inflation, or of the Fed’s replacing its inflation target with a goal for nominal gross domestic product.

The Fed chairwoman, Janet L. Yellen, will have a prime opportunity to elaborate on her own views in this debate next week, in a scheduled speech at the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyo.

But for now, Fed officials are openly discussing the need to approach policy choices differently, and holding off from interest rate increases as a result, but not quite concluding that the old rules no longer apply and embracing an alternate approach.

It’s an awkward place for a central bank to be, but until Ms. Yellen and her colleagues can find consensus around what the new framework for monetary policy ought to be — or conclude that the old models still have some usefulness — the uncertainty evident in the July minutes won’t change.

PARIS – The same type of populist discontent that fueled Brexit in the United Kingdom is on the rise throughout Europe, suggesting that policymakers have lost sight of the European project’s central objective: to ensure the wellbeing of all Europeans. As the first United Nations Human Development Report put it in 1990: “People are the real wealth of a nation.”

The best way to capitalize on the people of a country or region is through social equity.

Amartya Sen, in his magisterial The Idea of Justice, concluded that true social equity requires not equal treatment for all, but rather unequal treatment in favor of the poor and most disadvantaged. Mere equity in public finance or in the eyes of the law is not enough if we don’t also consider the different starting points for individuals and groups in society. Recognizing this, successive UN development reports since 1990 have made the case that both economies and societies are stronger when public policy puts people’s wellbeing first.

However, this outlook hasn’t yet taken root in the EU’s elite policymaking circles, where well-meaning economists and politicians often believe they are doing the right thing by balancing budgets and reining in spending, usually by cutting health, education, and infrastructure budgets. These policymakers, with little empirical evidence, believe that fiscal prudence today will lead to a stronger economy tomorrow.

This is the thinking behind the current policy mix in Europe, where fiscal austerity is combined with “structural reform,” meaning less spending on the social safety net and less regulation to protect workers. Obviously, the costs of these policies are mostly borne by the poor and the middle class.

But there are several other problems with this approach as well. First, it isn’t good for most people’s incomes. When the Oxford University economist Tony Atkinson looked at the UK’s economic performance through the lens of inequality, the 1980s, generally considered a strong decade in terms of growth, appeared much worse; and the 1990s, regarded as a low-growth decade, appeared much better.

Atkinson’s findings point to a central question: Who benefits from growth – the many or the few? If an economy can be said to be growing when a small minority receives most of the gains while everyone else’s lot stays the same or decreases, the concept of economic growth loses much of its meaning.

This leads to a second problem with the prevailing paradigm, which is that it puts abstract economic indicators before actual people. Because gross domestic product is the preferred gauge of any economy’s value, many factors that contribute to human wellbeing are ignored, and spending on fundamental needs, such as health and education, comes to be seen as an expense rather than an essential investment.

If policymakers viewed such spending as an investment, they could start thinking about how to maximize returns. Like all investments in human or fixed capital, there may be diminishing returns at high levels. So, rather than funneling economic benefits to the rich and assuming it will “trickle down,” policymakers should assess whether investing in opportunities for the poor actually does more for economic growth. In the US, the 1944 Servicemen’s Readjustment Act (better known as the GI Bill) was a success because it provided training for those most in need of it, enabling returning World War II veterans to re-enter the productive economy. The bill created a more educated workforce and ushered in a period of rising incomes for most Americans.

A third problem with the current approach is that its central objective is not full employment. It is time to return to the macroeconomic policies of the 1950s and 1960s, which recognized the benefits of full employment in fostering social stability and sustainable growth. As the Nordic model shows, high employment is good for the economy because it ensures adequate tax revenues to finance high levels of social investment, which creates a virtuous cycle.

Many European countries are now in a vicious cycle instead, with austerity policies worsening the problem of youth unemployment. This is not only unnecessary, but also wasteful, because it risks creating a generation that will be ill equipped to drive future growth. As John Maynard Keynes pointed out in 1937, “The boom, not the slump, is the right time for austerity at the Treasury.” In the current slump, European countries should be investing in their human capital to spur their economies’ potential growth.

The fourth problem is that European countries’ fiscal policies do not emphasize creativity and innovation, which benefits not only from a conducive regulatory environment, but also from high-quality education and infrastructure. Governments need to reduce bureaucratic red tape so that entrepreneurs can take more risks. But breakthrough technology companies such as Apple, Facebook, and Twitter also depend on people who had access to well-funded education systems. And while there is a growing “tech for good” sector in Europe, it will succeed only if it is supported by up-to-date infrastructure, which generally requires public outlays.

Policymakers in Europe (and elsewhere) need to adjust their thinking – especially their fiscal thinking – to put people first. Governments that make it their central objective to maximize human wellbeing end up not only encouraging higher economic growth, but also nurturing healthier politics.

After spending years dogged by unpaid debts, California labor leader Charles Valdes filed for bankruptcy in the 1990s—twice. At the same time, he held one of the most influential positions in the American financial system: chair of the investment committee for the California Public Employees’ Retirement System, or CalPERS, the nation’s largest pension fund for government workers. Valdes left the board in 2010 and now faces scrutiny for accepting gifts from another former board member, Alfred Villalobos—who, the state alleges, spent tens of thousands of dollars trying to influence how the fund invested its assets. Questioned by investigators about his dealings with Villalobos, Valdes invoked the Fifth Amendment 126 times.

ILLUSTRATIONS BY SEAN DELONAS

California taxpayers help fund CalPERS’s pensions and ultimately guarantee them, so they might wonder: How could a financially troubled former union leader occupy such a powerful position at the giant retirement system, which manages roughly $230 billion in assets? The answer lies in CalPERS’s three-decade-long transformation from a prudently managed steward of workers’ pensions into a highly politicized advocate for special interests. Unlike most government pension funds, CalPERS has become an outright lobbyist for higher member benefits, including a huge pension increase that is now consuming California state and local budgets. CalPERS’s members, who elect representatives to the fund’s board of directors, ignored concerns over Valdes’s suitability because they liked how he fought for those plusher benefits.

CalPERS has also steered billions of dollars into politically connected firms. And it has ventured into “socially responsible” investment strategies, making bad bets that have lost hundreds of millions of dollars. Such dubious practices have piled up a crushing amount of pension debt, which California residents—and their children—will somehow have to repay.

When California’s government-employee pension system was established in 1932, it was a model of restraint. Private-sector pensions were still rare back then, but California lawmakers had a particular reason for wanting a public-sector pension system: without one, unproductive older workers had an incentive to stay on the job and just “go through the motions” to get a paycheck, as a 1929 state commission put it. Pensions would encourage those workers to retire. The commission cautioned, however, against setting a retirement age so low that it would “encourage or permit the granting of any retirement allowance to an able-bodied person in middle life.”

Accordingly, California set its initial retirement age for state workers (and, beginning in 1939, for local-government employees) at 65, at a time when the average 20-year-old entering the workforce could expect to live for another 46 years, until 66. The system’s first pensions were modest, though far from miserly. An employee’s pension equaled 1.43 percent of his average salary over his last five years on the job, multiplied by the total number of years he had worked. That formula typically provided workers with pensions equal to half or more of their final salaries, noted California’s Little Hoover Commission, a government agency, in a 2010 study. For example, a state worker who retired at 65 after 40 years on the job would qualify for a pension equal to 57.2 percent of his average final salary (that’s 40 times 1.43). If that salary was $50,000, his pension would be nearly $29,000.

The pensions were funded by three sources: contributions from employers (that is, state and local governments); contributions from employees (though some governments opted to cover that expense); and money that the pension fund would gain by investing those contributions. With the 1929 stock-market crash in mind, California opted for a cautious investment approach, allowing the fund to buy only safe federal Treasury bonds and state municipal bonds. “An unsound system,” the 1929 commission warned, would be “worse than none.” The employees’ contributions were fixed, so if investment returns weren’t sufficient to fund the promised pensions, the employers’ contributions would have to increase to make up the difference.

In 1961, California enhanced non-public-safety state workers’ retirement packages by enrolling them in federal Social Security, a program that’s optional for state and local government employees. But the state made few other changes to the pension system over its first 30 years.

Then came the late sixties, a time of rapidly growing public-sector union power. In 1968, the California state legislature added one of the most expensive of all retirement perks, annual cost-of-living adjustments, to CalPERS pensions. Other enhancements followed quickly, including, in 1970, a far more generous pension formula: a worker’s pension was calculated from 2 percent, not 1.43 percent, of his average final salary, and he could start getting his pension at 60, rather than 65. Thus, an employee who worked for 40 years and retired at 60 with an average final salary of $50,000 could collect an annual pension equal to 80 percent of that sum, or $40,000; if he kept working for another five years, his pension fattened to 90 percent of his final average. In 1983, public-safety workers got an even better pension formula: 2.5 percent of average final salary for every year worked, which could be taken starting at 55. A police officer or firefighter who began work at 20 and retired 35 years later with a final average salary of $50,000 now qualified for a yearly pension of almost $44,000.

As benefits increased, so did pressure to pay for them by boosting CalPERS’s investment returns. The shift started in 1966 when voters approved Proposition 1, a measure, promoted by CalPERS, that let it invest up to 25 percent of its portfolio in stocks. The timing wasn’t ideal, since the long economic stagnation of the late sixties and seventies had left equity markets struggling for gains. But by the early eighties, markets were roaring again, and CalPERS asked for permission to invest up to 60 percent of its portfolio in stocks. Voters rejected that ballot initiative but approved another, Proposition 21, in 1984, which likewise let CalPERS expand its investments —and didn’t specify a percentage limit. Instead, Prop. 21 supposedly protected taxpayers with a clause that held CalPERS board members personally responsible if they didn’t act prudently. The proposition received the enthusiastic backing of government unions and CalPERS board president Robert Carlson, former head of the powerful California State Employees Association. CalPERS’s conservative investment approach, Carlson and other supporters argued, was shortchanging the state’s taxpayers. After all, the better the investment returns were, the less state and local governments would need to pay into the pension fund.

Despite the new investment strategy, the costs of the enlarged pensions weighed heavily on California’s budget. In 1991, with the nation mired in a recession and the state in a fiscal crisis, the California legislature closed the existing pension system to new workers, for whom it created a second “tier.” This less expensive plan no longer required the worker to make a pension contribution, and it lowered the value of his pension to 1.25 percent of his final average salary for every year he had worked; further, he could begin to receive the pension only at 65. A 40-year veteran with a final average salary of $50,000 would thus qualify for a $25,000 pension, plus Social Security benefits.

The state’s public-sector unions hated the new tier, of course, and their growing influence over CalPERS’s board of directors meant that it, too, was soon lobbying against the 1991 reform. Six of the board’s 13 members are chosen by government workers, and as union power grew in California, those six increasingly tended to be labor honchos. Two more members are statewide elected officials (California’s treasurer and controller), and another two are appointed by the governor—so by 1999, when union-backed Gray Davis became governor and union-backed Phil Angelides became state treasurer, the CalPERS board was wearing a “union label,” noted theNew York Times. As the newspaper added, critics worried that the board had become so partisan that its “ability to provide for the 1.3 million public employees whose pensions it guarantees” was in doubt.

The critics were right to worry about CalPERS’s bias. In 1999, the fund’s board concocted an astonishing proposal that would take all the post-1991 state employees and retroactively put them in the older, more expensive pension system. The initiative went still further, lowering the retirement age for all state workers and sweetening the pension formula for police and firefighters even more. Public-safety workers could potentially retire at 50 with 90 percent of their salaries, and other government workers at 55 with 60 percent of their salaries.

CalPERS wrote the legislation for these changes and then persuaded lawmakers to pass it. In pushing for the change, though, the pension fund downplayed the risks involved. A 17-page brochure about the proposal that Cal- PERS handed to legislators reads like a pitch letter, not a serious fiscal analysis. The state could offer these fantastic benefits to workers at no cost, proclaimed the brochure: “No increase over current employer contributions is needed for these benefit improvements.” The state’s annual contribution to the pension fund—$776 million in 1998—would remain relatively unchanged in the years ahead, the brochure predicted.

CalPERS board members also minimized the plan’s risks. Board president William Crist contended in the press that the bigger benefits would be covered by the pension fund’s market returns. Labor leader Valdes blasted critics who warned about potential stock-market declines, saying that they were trying to deny workers a piece of the good times. What the board members didn’t mention was that California law protected government pensions, so that taxpayers would be on the hook for any shortfall in pension funding. In essence, the CalPERS position was that government workers should carry zero risk, sharing the bounty when the fund’s investments did well but losing nothing when the investments went south.

But the board members knew that there was a downside. CalPERS staff had provided them with scenarios based on different ways the market might perform. In the worst case, a long 1970s-style downturn, government contributions to the fund would have to rise by billions of dollars (which is basically what wound up happening). CalPERS neglected to include that worst-case scenario in its legislative brochure. And though the board later claimed that it had offered a full analysis to anyone who asked, key players at the time deny it. Even the state senator who sponsored the law, Deborah Ortiz, says that lawmakers received little of substance from the fund’s representatives. “We probed and probed and asked questions 100 times,” she told theSan Jose Mercury Newsin 2003. “The CalPERS staff assured us that even in the worst-case scenario the state’s general fund would take a $300 million hit,” a manageable sum in a $99 billion state budget. (The actual cost to the state budget, it turned out, was more than ten times that estimate—and it’s still climbing.)

CalPERS also misled legislators and the press about the 1991 pension tier that it was pushing to repeal. In its brochure, the fund implied that the retirement pay that rank-and-file service workers got under the 1991 plan was tantamount to poverty. It didn’t mention that many state workers also received Social Security payments, which add substantially to retirement income.

California lawmakers easily passed the new pension deal in 1999. The bill, signed by Governor Davis with little fanfare, immediately generated pressure on local governments to match the new benefits for their own employees. In 2001, legislators passed a measure allowing municipal workers covered by the CalPERS system to bargain for the same benefits that the state workers had just won. Like state legislators, many local officials believed that CalPERS surpluses would pay for the benefits. Expensive new benefits spread across the state “like a grass fire,” Tony Oliveira, president of the California State Association of Counties, remembered in 2010.

That frenzy to expand benefits took place even though the air was already coming out of the economy. The tech-stock bubble deflated in the spring of 2000, shattering the NASDAQ market and driving down the Dow Jones Industrial Average. The American economy plunged into recession the following year, a slowdown made far worse by the terrorist attacks of September 11. By the close of trading on September 17, 2001, the Dow stood at 8,920.70, down nearly a quarter from its early-2000 all-time high of 11,722.

CalPERS has the exclusive power to determine the size of state and local governments’ contributions into the fund. As its investments tanked, it quickly boosted those contributions to compensate. By mid-decade, local officials were frantically telling the California press that the contributions were squeezing out other forms of spending. Glendale, a Los Angeles suburb, watched its annual pension bill rocket from $1.3 million in 2003 to $13.7 million in 2007—nearly a tenfold increase. San Jose’s tab almost doubled, from $73 million in 2001 to $122 million in 2007, and then rose even faster over the next three years, hitting a jaw-dropping $245 million in 2010. San Bernardino’s annual pension obligations rose from $5 million in 2000 to about $26 million last year. The state budget took a massive hit, too, its pension costs lurching from $611 million in 2001 to $3.5 billion in 2010.

Even those sums understated the problem. As a backlash grew to the larger bills that it was sending to municipalities and the state, CalPERS used a series of fiscal gimmicks to limit the immediate impact on balance sheets. Typically, to protect governments from violent swings in contributions every year, pension funds like CalPERS average their investment returns over three years, hoping that good years offset bad years. In 2005, CalPERS extended the performance average to 15 years, an extraordinarily long period that blended the fund’s losses in the 2000s with its gains way back in the 1990s—thus reducing state and local governments’ immediate costs, which remained overwhelming nevertheless. Then, in 2009, CalPERS told governments that they could pay off the higher bills from the previous year’s scary market drop over the next three decades, pushing the bill for the financial meltdown to the next generation. The pension fund made a similar move in 2011: after revising downward its absurdly optimistic predictions of future investment gains, it gave governments 20 years to finance the higher resulting costs.

Both Governor Arnold Schwarzenegger and his successor, Jerry Brown, scorched CalPERS for the tricks. “The state should decline to participate in any effort to shift more costs to our children,” said Schwarzenegger, who offered to give CalPERS $1.2 billion more out of his budget for pensions. Still trying to minimize the impact on current budgets, the fund declined and took a $200 million hike instead.

CalPERS contended that the state’s escalating pension costs shouldn’t be blamed on the expensive 1999 legislation. The real culprit, it claimed, was the stock market’s slump, which hurt investment returns. But back when it was promoting the legislation in 1999, CalPERS had hyped Pollyannaish projections of 8 percent average annual returns, which proved crucial to getting the change through the legislature.

Another reason not to buy CalPERS’s stock-market excuse is that its losses have been far worse than they should have been, thanks to a number of overly risky investment practices. Wilshire Consulting reported last year that CalPERS’s returns over the past five years have trailed those of 99 percent of large public pension funds.

Why? Recall that back in 1984, Proposition 21 gave CalPERS’s board greater latitude in allocating investments. Initially, the shift seemed to bolster the fund’s assets: CalPERS’s investment income rose from $1.5 billion in 1982 to $3.3 billion in 1985 to $6.1 billion in 1990. Even more spectacularly, CalPERS earned $68 billion during the tech boom of 1994 through 1998. But those rich gains had an unforeseen consequence: they prompted the call for higher benefits that resulted in the lavish new pension deal of 1999, which, in turn, led to a search for even greater investment returns in progressively riskier investment strategies.

CalPERS’s investments in real estate, which had begun cautiously in the 1960s, exemplify the wrong turn. The fund started expanding its real-estate portfolio during the 1990s tech boom. Then, as its stock investments slid at the turn of the millennium, it chased even higher returns in real estate. Between 2004 and 2006, as the country’s real-estate bubble was inflating, CalPERS pumped $7 billion into the sector, most of it in a few places that later became ground zero for the housing bust. By 2008, the fund owned 288,000 homes and lots, 80 percent of them in property-bubble states California, Florida, and Arizona. The fund’s real-estate portfolio grew from 5 percent of its assets in mid-2005 to 10 percent by June 2008, even as real estate was already collapsing in CalPERS’s biggest markets.

The portfolio included a $500 million bet on two large apartment complexes in New York City—Peter Cooper Village and Stuyvesant Town—that went bust in a high-profile default. There was also an investment of nearly $1 billion in Landsource Communities, which planned to develop some 15,000 acres in California’s Santa Clarita Valley but eventually filed for bankruptcy. By 2011, the value of the fund’s real-estate holdings had declined by 49 percent, resulting in $11 billion in losses.

Desperate for higher returns, CalPERS also bought the riskiest portions of collateralized-debt obligations, accumulating $140 million of them by 2007. These were the packages of debt, largely subprime mortgages, whose defaults helped trigger the 2008 financial meltdown. According to a 2007 story by Bloomberg News, CalPERS bought these investments, known as “toxic waste” on Wall Street, from Citigroup, one of the sinking firms that the government later bailed out. “I have trouble understanding public pension funds’ delving into equity tranches, unless they know something the market doesn’t know,” Edward Altman of New York University told Bloomberg about the CalPERS buys. “If there’s a meltdown, which I expect, it will hit those tranches first.”

The decline in property values also squeezed CalPERS’s cash flow, forcing the fund to sell off weakened stocks “at exactly the wrong time,” concludes a study by Andrew Ang, a professor at Columbia University’s business school, and Knut Kjaer, an investment manager. Their paper on Cal- PERS’s panic selling in 2008 notes that the cash-hungry fund sold 2.3 million shares of Apple Inc. for $370 million; those shares would be worth nearly $1.5 billion today.

Prop. 21 had another effect that proved disastrous for CalPERS’s performance: turning the fund into a mammoth would-be activist. The initiative passed at a time when many companies were closing down their own corporate-directed pension funds and switching to defined-contribution plans, in which the assets are directed by the wishes of individual employees, not concentrated in a single fund. As a consequence, the newly empowered CalPERS was left one of the biggest shareholders in America. And over time, the CalPERS board started using its newfound power to enforce its own political agenda, often without meeting its fiduciary responsibility to invest the fund’s money wisely.

Leading the charge after becoming state treasurer in 1999 was Phil Angelides, who announced that he wanted to “mobilize the power of the capital markets for public purpose.” During Angelides’ tenure, according to aSacramento Beeanalysis, a third of his office’s press releases concerned his actions on the boards of CalPERS and of CalPERS’s sister fund, the California State Teachers’ Retirement System (CalSTRS). For example, soon after Angelides took his board seats, he persuaded CalPERS and CalSTRS to divest shares in tobacco companies. Depressed at the time, those shares soon began to rise; a 2008 CalSTRS report estimated that the funds missed $1 billion in profits because of the divestiture. CalPERS also banned investments in developing countries like India, Thailand, and China because they didn’t meet Angelides’ labor or ethical standards. A 2007 CalPERS report calculated that its investments in developing markets underperformed an international emerging-markets index by 2.6 percent. Cost to the fund: $400 million.

Angelides wasn’t alone. Union officials and other CalPERS board members pursued their own political agendas, demanding, for instance, that the fund not invest in firms and countries that lacked worker-friendly labor policies. By 2011, according to a Mercer Consulting report, CalPERS had adopted 111 different policy statements on the environment, social conditions, and corporate governance, all dictating or restricting how its funds could be invested.

CalPERS leaped into “social investing” at exactly the wrong time. That trend had gained currency in the 1990s with an emphasis on buying into environmentally “clean” companies. Tech firms were high on the list, so the 1990s Internet start-up boom made social investing seem like a sound financial strategy. But when CalPERS debuted its Double Bottom Line initiative in 2000—so called because it would supposedly produce both good returns and good social policy—the tech bubble had already popped.

Many socially conscious investors then turned their attention to another industry that didn’t pollute: finance. One social-investing research firm named Fannie Mae the leading corporate citizen in America from 2000 through 2004. Other finance firms that attracted big cash from social investors included AIG, Citigroup, and Bank of America, according to an analysis by American Enterprise Institute adjunct fellow Jon Entine. When the market for shares of these firms imploded in 2008, so did the performance of social investors.

Yet another feature of CalPERS that has cost taxpayers is double-dealing by the board, ranging from awarding contracts to political donors to alleged outright corruption. In 2010, Jerry Brown, California’s attorney general at the time, launched a lawsuit accusing Alfred Villalobos of trying to bribe current board members (including Charles Valdes) to win investment business for his clients, mostly large financial firms that wanted a piece of the huge CalPERS portfolio. Villalobos pulled in $47 million as a go-between, the suit charged. A month after the lawsuit was announced, Villalobos filed for personal bankruptcy, temporarily blocking the suit. In 2011, the Internal Revenue Service accused him of intentionally depleting his assets while in bankruptcy, including gambling some away in Nevada casinos. News reports revealed that Villalobos had previously filed for bankruptcy, a decade before serving on the CalPERS board.

The lawsuit also accused former CalPERS chief executive Fred Buenrostro of accepting gifts from Villalobos. Separately, a Securities and Exchange Commission lawsuit filed last year accused Buenrostro of forging a document to help Villalobos win a big payment from a client. An internal CalPERS investigation quoted Buenrostro’s wife as calling her husband a “puppet” of Villalobos. The report also pointed out that Buenrostro often intervened with the CalPERS staff on behalf of his acquaintances in the investment world—“friends of Fred,” as the staffers called them.

Buenrostro and Villalobos have denied any wrongdoing, and investigations continue. In December 2011, after more than a year’s delay, a judge finally ruled that the state’s case against Villalobos could proceed, his bankruptcy filing notwithstanding.

These blockbuster allegations of influence-peddling came after nearly a decade of warnings of apparent conflicts of interest within CalPERS, promptingBusinessweekto observe “an unpleasant whiff of pork-barrel politics rising from the board.” One example involved Ron Burkle, a major political donor in California. Burkle was a significant giver to Angelides’ campaign for treasurer, and he employed another board member, former San Francisco mayor Willie Brown, to do legal work for him. But Burkle’s closest ties were with Governor Gray Davis: he gave $600,000 to Davis’s gubernatorial campaign and appointed Davis’s wife to the board of directors of one of his companies. CalPERS invested some $760 million in Burkle’s private equity funds from 2000 through 2002.

Another disturbing case involved board member Sean Harrigan, also an officer of the United Food and Commercial Workers International Union. Between 2000 and 2004, theSacramento Beereported, Harrigan openly solicited donations for a union campaign fund from various investment companies that won multimillion-dollar deals from CalPERS. The companies ponied up $300,000. A CalPERS spokesperson said that the fund was unaware that Harrigan was soliciting donations from firms that did business with it, adding that there was no prohibition within CalPERS against the practice.

Criticized for scandals and for its staggering long-term pension debt, CalPERS has endorsed a series of minor reforms. They include an assessment of the board’s performance every two years by an independent auditor and the online posting of board members’ and staffers’ travel expenses. CalPERS also now limits to $50 the gifts that board members can receive from anyone doing business with the fund. However, Governor Brown’s proposal to reform the CalPERS board by adding two new members with financial expertise failed to make it past the union-friendly state assembly, which argued that any changes to the board’s composition should be negotiated between government unions and the state. For now, it seems, CalPERS will remain under union control.

CalPERS and its legislative allies keep resisting the one reform that would truly free California taxpayers from this ruinous pension system: moving it toward a 401(k)-style defined-contribution plan, as other states and municipalities, including Utah and Rhode Island, have done. In a defined-contribution plan, the government’s commitment ends after it makes its annual required contribution into a worker’s retirement account; the taxpayer’s liability also ends there. Under the CalPERS regime, by contrast, employees are guaranteed benefits even if the government hasn’t put aside money to pay for them, placing all the future liability on the taxpayer. Defined-contribution systems like Utah’s also aren’t as easy to manipulate politically as CalPERS-style pension plans because the money goes into workers’ individual accounts, not into a massive portfolio controlled by a politically appointed or an elected board of directors.

Right now, the pension bill that Californians owe because of CalPERS is enormous. In a December 2011 study, former Democratic assemblyman Joe Nation, a public finance expert at Stanford University, estimated that CalPERS’s long-term pension debt is a sizable $170 billion if CalPERS achieves an average annual investment return of 6.2 percent in years to come. If the return is just 4.5 percent annually—a rate close to what more conservative private pensions often shoot for—the fund’s long-term liability rises to a forbidding $290 billion. By contrast, CalPERS itself estimated its long-term unfunded liability at merely $80 billion, using a lofty projected annual investment return of 7.75 percent. (The fund has recently cut that estimate to 7.5 percent.)

Last August, California did pass modest pension reforms, which apply mostly to new workers hired starting this year. Nation estimates that the reforms cut the state’s long-term pension debt by 10 percent at most. Clearly, the state needs to do much more. In the last five years, three California municipalities—Vallejo, Stockton, and San Bernardino—have filed for bankruptcy, each citing retirement costs as a significant factor. But bankruptcy may not afford cities any relief from pension costs; CalPERS argues that cities have no right in federal bankruptcy court to reduce pensions, since the fund is not a creditor of these municipalities but an arm of state government. Vallejo, which has already emerged from bankruptcy, did nothing to reduce its pension costs in Chapter 9, and its employee costs remain sky-high. To employ a cop in Vallejo still requires $230,000 a year, including $47,000 in annual CalPERS costs.

Meanwhile, CalPERS’s rejoinders to its growing chorus of critics continue to mislead. Responding to a September 2012 opinion piece by Gary Jason, a California State University professor, about the impact of pension costs on municipal bankruptcies, CalPERS claimed that pensions were only a small part of the problem, accounting for just 10 percent of Stockton’s budget, for instance. But in 2011, when Stockton declared a fiscal emergency, it listed $29 million in payments to CalPERS and $7 million to repay previous pension borrowings, which together equaled 21 percent of its total general-fund spending of $168 million. In a March 2011 analysis of its fiscal plight, city officials blamed “uncontrolled pension, health, and other benefit cost increases.”

CalPERS also understates the growing financial stress caused by pension obligations. This past August, for instance, board member Rob Feckner published a disingenuous op-ed in theSacramento Beeresponding to critics of Cal- PERS’s most recent poor investment performance. Feckner said that the media misunderstand the fund’s investment strategy, which focuses not on a single year but on long-term results. He noted that over the last 20 years, the fund had hit its investment targets more frequently than it had missed them. Yet he ignored the sharp increases in taxpayer contributions that CalPERS demanded when it missed its targets, as well as the fiscal smoothing gimmicks that it wielded to keep contributions from rising even more.

CalPERS’s advocacy for higher benefits and its poor investment performance in recent years have locked in long-term debt in California and driven up costs, problems for which there are no easy solutions. As former Schwarzenegger economic advisor David Crane, a California Democrat, has said of the fund’s managers and board: “They are desperate to keep truths hidden.”

Steven Malanga is the senior editor ofCity Journaland a senior fellow at the Manhattan Institute. His latest book isShakedown: The Continuing Conspiracy Against the American Taxpayer.

“Low fear levels most often occur at times of rising stock prices and tranquil markets,” writes Shell. “But low VIX readings are often viewed as a sign of investor complacency as risks build.”

While FDR once famously told Americans that “the only thing we have to fear is fear itself,” Shell quotes Greg Rutherford, the CEO of Cavalier Investments, who altered the famous quote to make it applicable to the dangers of a complacent stock market: “The only thing we have to fear is the lack of fear.”

In the USA Today column, Rutherford ticks off a list of worries that could challenge the market’s current calm. “(Price-to-earnings ratios) are extremely high,” he tells USA Today. “GDP is weak.

But as an article in Bloomberg points out, there’s a case to be made for this rally to continue, despite the fact that the bull market has lasted for almost seven and a half years, making it the second longest bull market in market history.

“There is a lot to like in a market as hated as this one,” writes Oliver Renick, a Bloomberg writer.

Renick argues that it’s a good sign that a rotation has taken place in which growth stocks are now pushing the broader indexes higher instead of the dividend-rich defense stocks that powered the rally last year.

“Nary a defensive share is rallying as leadership in the S&P 500 Index switches from the dividend-paying bond surrogates that ruled 2015 to technology, banks and commodity firms that benefit from an expanding economy,” writes Renick.

Renick adds that computer and software makers, financial firms and industrial companies have all climbed at least 9.7 percent since the two-day rout that followed the surprise Brexit vote on June 23.

“The rally is straining the main case of the bears, which boils down to an observation that the bull market that began in March 2009 has gone on for too long,” he adds.

The stock rally in recent weeks may have something to do with Hillary Clinton’s surge in the polls against Republican challenger Donald Trump.

As Barron’s pointed out in its cover story over the weekend, Hillary’s victory would be more easily digested by the market than Trump’s because of the Democrat’s “mostly moderate instincts” and “predictable policy prescriptions.”

Paul La Monica, a veteran columnist with CNN Money, agrees with this thinking.

In a piece posted on the CNN Money Website Monday, La Monica argues that Clinton is the known quantity and Trump is the wild card in the race.

“Even though it seems unlikely that he would remain so bombastic and unpredictable if elected, the truth is that nobody really knows,” La Monica concludes.

Repression and the incompetence of Abdel-Fattah al-Sisi are stoking the next uprising.

IN EGYPT they are the shabab al-ahawe, “coffee-shop guys”; in Algeria they are the hittistes, “those who lean with their backs to the wall”; in Morocco they go by the French term, diplômés chômeurs, “graduate-jobless”. Across the Arab world the ranks of the young and embittered are swelling.In most countries a youth bulge leads to an economic boom. But Arab autocrats regard young people as a threat—and with reason. Better educated than their parents, wired to the world and sceptical of political and religious authority, the young were at the forefront of the uprisings of 2011. They toppled rulers in Tunisia, Egypt, Libya and Yemen, and alarmed the kings and presidents of many other states.Now, with the exception of Tunisia, those countries have either slid into civil war or seen their revolutions rolled back. The lot of young Arabs is worsening: it has become harder to find a job and easier to end up in a cell. Their options are typically poverty, emigration or, for a minority, jihad.

This is creating the conditions for the next explosion. Nowhere is the poisonous mix of demographic stress, political repression and economic incompetence more worrying than in Egypt under its strongman, Abdel-Fattah al-Sisi.

Battle of the youth bulge

As our briefing on young Arabs sets out, the Middle East is where people are most pessimistic and most fearful that the next generation will fare worse than the current one. Arab populations are growing exceptionally fast. Although the proportion who are aged 15-24 peaked at 20% of the total of 357m in 2010, the absolute number of young Arabs will keep growing, from 46m in 2010 to 58m in 2025.As the largest Arab state, Egypt is central to the region’s future. If it succeeds, the Middle East will start to look less benighted; if it fails, today’s mayhem will turn even uglier. A general who seized power in a coup in 2013, Mr Sisi has proved more repressive than Hosni Mubarak, who was toppled in the Arab spring; and he is as incompetent as Muhammad Morsi, the elected Islamist president, whom Mr Sisi deposed.The regime is bust, sustained only by generous injections of cash from Gulf states (and, to a lesser degree, by military aid from America). Even with billions of petrodollars, Egypt’s budget and current-account deficits are gaping, at nearly 12% and 7% of GDP respectively. For all of Mr Sisi’s nationalist posturing, he has gone beret in hand to the IMF for a $12 billion bail-out.Youth unemployment now stands at over 40%. The government is already bloated with do-nothing civil servants; and in Egypt’s sclerotic, statist economy, the private sector is incapable of absorbing the legions of new workers who join the labour market each year. Astonishingly, in Egypt’s broken system university graduates are more likely to be jobless than the country’s near-illiterate.Egypt’s economic woes stem partly from factors beyond the government’s control. Low oil prices affect all Arab economies, including net energy importers that depend on remittances. Wars and terrorism have kept tourists away from the Middle East. Past errors weigh heavily, too, including the legacy of Arab socialism and the army’s vast business interests.But Mr Sisi is making things worse. He insists on defending the Egyptian pound, to avoid stoking inflation and bread riots. He thinks he can control the cost of food, much of which is imported, by propping up the currency. But capital controls have failed to prevent the emergence of a black market for dollars (the Egyptian pound trades at about two-thirds of its official value), and has also created shortages of imported spare parts and machinery. This is stoking inflation anyway (14% and rising). It is also hurting industry and scaring away investors.Sitting astride the Suez Canal, one of the great trade arteries of the world, Egypt should be well placed to benefit from global commerce. Yet it lies in the bottom half of the World Bank’s ease-of-doing-business index. Rather than slashing red tape to set loose his people’s talents, Mr Sisi pours taxpayers’ cash into grandiose projects. He has expanded the Suez Canal, yet its revenues have fallen. Plans for a new Dubai-like city in the desert lie buried in the sand. A proposed bridge to connect Egypt to Saudi Arabia sparked protests after Mr Sisi promised to hand back two Saudi islands long controlled by Egypt.Even Mr Sisi’s Arab bankrollers appear to be losing patience. Advisers from the United Arab Emirates have gone home, frustrated by an ossified bureaucracy and a knucklehead leadership that thinks Egypt needs no advice from upstart Gulfies—mere “semi-states” that have “money like rice”, as Mr Sisi and his aides are heard to say in a leaked audio tape.

Better the general you know?

Such is Egypt’s strategic importance that the world has little choice but to deal with Mr Sisi. But the West should treat him with a mixture of pragmatism, persuasion and pressure. It should stop selling Egypt expensive weapons it neither needs nor can afford, be they American F-16 jets or French Mistral helicopter-carriers. Any economic help should come with strict conditions: the currency should ultimately be allowed to float; the civil service has to be slimmed; costly and corruption-riddled subsidy schemes should be phased out. The poorest should in time be compensated through direct payments.All this should be done gradually. Egypt is too fragile, and the Middle East too volatile, for shock therapy. The Egyptian bureaucracy would anyway struggle to enact radical change. Yet giving a clear direction for reform would help to restore confidence in Egypt’s economy. Gulf Arabs should insist on such changes—and withhold some rice if Mr Sisi resists.For the time being talk of another uprising, or even of another coup to get rid of Mr Sisi, has abated. Caught by surprise in 2011, the secret police are even more diligent in sniffing out and scotching dissent. But the demographic, economic and social pressures within Egypt are rising relentlessly. Mr Sisi cannot provide lasting stability. Egypt’s political system needs to be reopened. A good place to start would be for Mr Sisi to announce that he will not stand again for election in 2018.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.